You’ve reached retirement, paid off your mortgage and have started thinking about your future living situation. You and your spouse are mobile and independent, meaning that continuing to live in your home for now could be a cost-effective and comfortable option. But thinking 5, 10, 15 years down the line, will you be in need of more handicap accessible housing? If so, are there renovations you could be doing now to be able to live in your home for longer? Maybe you’re even considering how you’ll cover unexpected medical expenses in the coming years. Keep reading to learn how retirees can tap into the equity their home provides by taking out a HELOC and continuing to enjoy retirement at home.
What Is a HELOC?
HELOC stands for “Home Equity Line of Credit.” It is a line of credit given based on your home’s equity, which is the difference between its fair market value and your current mortgage balance. In addition to your home’s equity, your credit score and income level may affect the credit limit offered as well. When receiving a HELOC, a lien is put against your property, with your home serving as collateral. A HELOC is considered to be a fairly safe loan option for banks, seeing as your home is on the line and at risk of foreclosure should you default on the payments.
How Does a HELOC Work?
Like a credit card, there will be a maximum credit limit determined. When working with a HELOC, you’ll have a draw period and a repayment period. The draw period is the predetermined amount of time (10 years, for example), that you’ll have to access the line of credit. During this time, you can access as much (up to the maximum amount) or as little of the available funds as you’d like. You can pay back the funds and reborrow it over and over again as needed. Again, similar to a credit card, you may be given a card or even a special checkbook you can use to make purchases. But even as you’re withdrawing funds, you will still be required to make minimum payments monthly throughout the draw period.
Once the repayment period begins, you’ll be responsible for paying back the remaining amount owed. Depending on your lender, this may continue to be paid back in monthly installments, or you could be expected to pay back the loan in its entirety as one lump sum.
HELOC vs. Home Equity Loan
While the names sound similar, there are a couple of substantial differences between a home equity loan and a home equity line. In general, a HELOC offers more flexibility than a loan. Why? Because you have the ability to only borrow what you need to, pay it back and borrow it again. Alternatively, a home equity loan (sometimes considered a second mortgage), requires you to receive all of the money in one lump sum. You do not have the option to take less than the entire amount. And from the moment you take out that loan, you begin accruing interest on the amount in its entirety. By comparison, you only pay interest on what you’ve borrowed from your HELOC, not the total amount available to borrow.
With a home equity loan, it’s likely your payments will stay the same month to month thanks to a fixed interest rate. With a HELOC, your interest rate can vary month to month, meaning your monthly payments may vary as well.
When Should I Take Out a HELOC?
HELOCs are typically used to cover home renovations, medical expenses, consolidating debt and other “needs” more than “wants,” especially considering someone’s home serves as the collateral. If you’re considering taking out a HELOC to help cover expenses in retirement, it’s important to note the recent tax changes by The Tax Cuts and Jobs Act of 2017. According to this recent change, the interest being paid on HELOCs is now only tax-deductible if it’s “used to buy, build or substantially improve the taxpayer’s home that secures the loan.”1 If you’re using the money to consolidate debt, pay off medical expenses or any other reason, the interest being paid is no longer tax-deductible.
Along with the potential tax advantage, HELOCs can also be an appealing option for retirees thanks to the ability to borrow large amounts of money at interest rates that are typically lower than credit cards or unsecured loan types.
As you look to stay in your beloved home for longer, you may need to come up with a plan for making your home more accessible, consolidating debt or paying for unexpected medical expenses. Your home, which may be paid off in its entirety or nearly there, can offer a substantial amount of equity you can use to do what you need to in order to enjoy retirement comfortably and on your terms. But as always, it’s important to speak with your tax professional and financial advisor before determining if a HELOC may be advantageous for you and your retirement.